Module 3: When do markets fail?

Real world examples of (proposed) pollution taxes:

Pigouvian policies are in theory efficient, but not without caveats:

Wait a minute. Is there another way?

The idea is simple: assign the property right to either party, and let them negotiate with each other.

The Coase theorem

If property rights are well-defined, and there are no transaction costs, then no matter what the initial allocation of resources, negotiation between parties will reach a pareto-optimal outcome WITHOUT interventions from the government.

How is the Coase theorem useful?

All we need is a “clearly-defined” property right structure, and then we can:

People who profit off of harmful behaviors, when you take away that money — because you take them to court and you sue them, as I have done — it’s extraordinary how they will change behaviors. They have to be held accountable.
-Senator Kamala Harris

The Mock Trial

Jon Snow vs. Daenerys Targaryen (2019)

Paper I gave Jon

Your name is Lord Jon Snow, a rancher living near the Long Lake, a small lake in the state of Wyoming. The lake is the only freshwater source nearby, and your herd of cattle depends on that lake to survive. Unfortunately, a farmer nearby named Daenerys Targaryen also wants control for the Long Lake to irrigate his field, and there is no way that the lake can be shared between you two. You think you are entitled to the right to use the lake, so you decide to take him to court.

According to the best of your estimate, the lake generates $X worth of value to you. That is, if you lose control of the lake, there will be about $X worth of economic damage to your cattle.

Paper I gave Dany

Your name is Queen Daenerys Targaryen, a farmer/landowner living near the Long Lake, a small lake in the state of Wyoming. The lake is the only freshwater source nearby, and your farmland depends on that lake to remain irrigated. Unfortunately, a rancher nearby named Jon Snow also wants control for the Long Lake to feed his cattle, and there is no way that the lake can be shared between you two. You think you are entitled to the right to use the lake, so you decide to take him to court.

According to the best of your estimate, the lake generates $Y worth of value to you. That is, if you lose control of the lake, there will be about $Y worth of economic damage to your cattle.

The polluter-pays principle

Assigning the “right to clean environment” to the public: polluters have to seek permission from the public (pay) in order to pollute.

Basic Components of a Cap-and-Trade are:

  1. Establish a policy cap, i.e., the optimal quantity of pollution emission/resource extraction for the society
  2. Issue permits to the polluters/extractors with the total amount of quota equal to the cap
  3. Each polluter’s emission cannot exceed the amount of quota they hold
  4. Establish a market for the polluters to trade their quotas with each other

What changed?

  1. The permit (and the pollution at large) is now a private good:
  1. There is now a market to trade these permits:

Quantity instrument in the fishery example

Recall the fishery problem last time, where an open-access resource faces rent dissipation: * After a certain point, new entry to the fishery decreases everybody else’s catch * An open-access fishery will be overfished because the fishery cannot limit entry

\[MC = 10\]

For the fishery to have the highest positive benefit, we need to solve:

Marginal Benefit = Marginal Cost

where MB is the slope of the total benefit, or \[10 = 100 - 4B\] \[B^*=22.5\]

An open-access outcome is characterized by:

Total Benefit = Total Cost

where at such point each and every boat just breaks even from the fishery. Notice that the total cost is just TC=10B, we have:

\[100B - 2B^2 = 10B\]

\[B^{OA}=45\]

Alaska’s Salmon Regulation

Rights-based policies

Give 22.5 units of permits to all fisherman/woman, i.e., limits B*=22.5

Rights-based approach works better:

Alaska’s ITQ restriction (Kroetz 2017)

Permits (quota) assigned to vessel sizes:

What’s gonna happen?

Real-world rights-based programs

Caveats about Cap-and-Trade

If tax and cap-and-trade are equivalent, then what is the fuss about choosing carbon tax or carbon trading?

The Role of Uncertainty

Prices vs. Quantities

Are common-pool resources always better governed by governmental regulation?

The Case for Privatization (Enclosure)

Coase theorem also clearly suggests that if property rights are clearly-defined, then the resource allocation will be efficient.

Trophy Hunting

A bit about Mozambique

Coutada 11: the Meat Locker

In year 1994, a South African named Mark Haldane leased Coutada 11 from the Mozambique government

Mark wanted to set up a trophy hunting program in the area to attract wealthy Westerners, so he worked with the locals:

Trophy hunting site opens up:

What happened after a couple of years?

Cape Buffalo: from 2100 to over 21000 Sable Antelope: from 44 to over 5000

And, financially, the program is completely self-sustainable.

Question: why is that?

Any problems/concerns with the approach?

Most modern economic theory describes a world presided over by a government (not, significantly, by governments), and sees this world through the government’s eyes. The government is supposed to have the responsibility, the will and the power to restructure society in whatever way maximizes social welfare; like the US Cavalry in a good Western, the government stands ready to rush to the rescue whenever the market ‘fails’, and the economist’s job is to advise it on when and how to do so. Private individuals, in contrast, are credited with little or no ability to solve collective problems among themselves. This makes for a distorted view of some important economic and political issues. -Sugden(1986)

Coase and Pigou represent two alternate school of thoughts

This is far from reality

Top-down approach may not work well in reality in those situations

The top-down approach will need: * Knowledge about localized benefit and costs * Strong, local enforcement * Free of corruption

Recall that in the one-shot prisoner’s dilemma game, self-interested individuals end up in a socially non-optimal (Nash) equilibrium.

What if the game is not played “one-shot”, but are played for multiple rounds?

Axelrod’s Tournament

In 1980, Robert Axelrod, professor of political science at the University of Michigan, held a tournament of various strategies for the prisoner’s dilemma.

The basic rule of the tournament is this: * Each player is paired with another random player in the pool * The game is going to play 200 rounds * The final score is the sum of total scores in all rounds

Different strategies emerge

The “Tideman and Chieruzzi”

  1. Every run of defections played by the opponent increases the number of defections that this strategy retaliates with by 1.

  2. The opponent is given a ‘fresh start’ if:

Who wins?

Benchmark:

With a maximum of 600 points, here they are:

The Follow up Tournaments

Implications from Axelrod’s Tournament

How does that help governing the commons

Ostrom’s Observation

Rather than using a pen and a pencil, Ostrom really went into the field:

What does she find?

Ostrom’s principles of designing long-surviving institutions

  1. Define boundaries clearly
  2. Design FAIR rules to use the resource (usually proportional to the benefit)
  3. Involve the participants into the rule-making process
  4. Monitor and enforce these rules locally
  5. Apply gradual sanctions to violators

The power of norms

These principles are usually conveyed through norms

What can threaten these self-governing rules?

Takeaways from this module

There are three schools of thought to correct market failure:

TQs from you

I strongly identify myself with the notions of the Coase Theorem. I believe that when you get to the grassroots level of human welfare, individuals looking to have the best outlooks for other is the foundation of a just society. Individuals will consistently look to get the best/most out of any situation they are - people may can have the potential to do such when only including parties that would be affected. Just like the individuals involved, government will look to gain something out of being in a situation as there must be some type of incentive/motivation in their attendance. The elimination of government in matters of environmental economics leaves the solution to be dealt with the parties involved where the two, three or however many don’t lose any benefit from unnecessary government intervention.

President Reagan ran on the notion the government isn’t the solution to problems but itself is the problem. A hands off approach by government would give the proper room for those involved to settle the environmental issue.